By Emily Moré Hollis, CFA Partner
The Fed is currently holding a mortgage portfolio that is bigger than Fannie Mae’s or Freddie Mac’s, along with a massively expanded government portfolio. Assets have grown to more than $3 trillion. With only $55 billion in equity, the Fed has a capital-to-assets ratio of 1.8 percent. On top of this low capital-to-assets ratio, the Fed holds investments in longer-term mortgage-backed securities of greater than $900 billion. And it is buying more to the tune of $40 billion a month! This profile in any financial institution would be an examiner’s nightmare. But is it? Will the Fed have an immense problem on its hands if rates rise?
Well, not really. The Fed does not keep its books on a market value basis, so its book capital would be unaffected. The Fed accounts for its securities at cost, not fair market value. Also, under an accounting policy set by the Fed in 2011, if it had losses, it would not reduce book capital. The net loss would go against the interest that the Fed pays to the U.S. Treasury which, by the way, has
increased fourfold since 2005 because of these higher-yielding assets. In other words, if the Fed had a loss equal to its total capital of $55 billion, its book capital would still be $55 billion. Still, to examine interest rate risk, we must take a look at the Fed’s assets and liabilities.